Kenneth Clarke's Ministry of Justice is embroiled in a row with Revenue & Customs (HMRC) over its planned no-win, no-fee legal reforms after tax chiefs demanded an exemption for their use of the controversial legal arrangements.

Clarke, who recently ran into controversy over comments about rape, introduced plans late last year that would prevent victorious litigants claiming their lawyer's success fees from defendants.

The justice secretary's reforms have been brought in to deal with "ambulance-chasing" lawyers in personal injury cases where the threat of huge fees for a losing side can encourage them to settle early.

But the move to restrict the use of conditional fee arrangements applies not just to personal injury cases but also to a range of other legal disputes, including insolvency situations. The plans have raised fears that insolvency practitioners may find it harder to pursue fraudulent company directors to recover cash for creditors. HMRC would be the biggest loser, with its losses due to insolvencies and fraud running into billions of pounds every year.

Critics of the Ministry of Justice's plans say that the reforms are being rushed through, and will result in huge losses to the exchequer.

As the major creditor in most insolvency situations, HMRC submitted a response to the consultation process on the reforms this year and is now in talks with the Ministry of Justice about finding a solution to the problem. Revenue & Customs is believed to be particularly worried that the new regulations may restrict its ability to recover funds in even the most flagrant cases, such as carousel frauds.

R3, the Association of Business Recovery Professionals, is spearheading a campaign to get insolvency situations exempted from the new regulations. Research carried out by the association over the last month suggests that the new rules could reduce the returns to creditors in recovery situations by almost 50%.

In 23 cases considered by R3, the availability of conditional fee arrangements and insurance against losing a case – another cost that is currently recoverable – meant a further return to creditors of £7.6m.

Frances Coulson, president of R3,said: "Under these proposals it will be harder for insolvency practitioners to recoup money from dodgy directors, so creditors such as the business community and HMRC could be left with nothing. It is essential that insolvency is exempt from these proposals so that businesses and HMRC are not left out of pocket and wrongdoing is not seen to be excused. Every penny left in the pocket of a director in a carousel fraud case is likely to fund another fraud."

Andy Slaughter, the shadow justice minister, said: "The government's insistence on a one-size-fits-all approach to their plans for radically reshaping civil justice threatens to punish ordinary citizens, honest hard-working small businesses and, in this case, the public purse itself."

A spokesman for the Ministry of Justice said: "We are considering the impact of abolishing CFA [conditional fee arrangements] recoverability in insolvency and related proceedings. These proceedings can bring substantial returns to creditors, including Her Majesty's Revenue & Customs. We are therefore discussing the specific implications with a view to reaching a satisfactory conclusion."

A spokesman for Revenue & Customs said: "HMRC is in discussion with the Ministry of Justice about the implications of the Jackson Report but is unable at present to comment further on this matter."

The row is a further embarrassment for Ken Clarke, under pressure from the right over his proposals to reduce sentences for those pleading guilty early and from the left for his gaffes on the subject of rape.